Who Needs Banks?

In the face of a continuing difficult credit environment, more borrowers are turning to peer-to-peer lending networks, which directly connect lenders and borrowers. These networks have recently financed nearly half a billion dollars in lending. Ray Fismanexamines these networks and discusses the conflicting economic research on them. While economists have found some evidence of “human frailty and bias” in lending decisions, one recent study of a specific network concluded that the “credit market operates quite efficiently and without a bank pocketing a slice of the proceeds.” (Earlier: a word on Prosper.) [%comments]

COMMENTS: 7

Two apparent limitations in P2P lending:
1) Loans over $20k-$25k are extremely difficult to raise the funds for. As a member of Prosper, I noticed that the larger loans took much longer to close, if they did. This would be a serious problem for any commercial business or even small business owner.
2) Ability to analyze credit quality. Let’s face it, there’s not a whole lot of data to guage credit risks. At Prosper, they provided some information, but nothing like what you use to apply for a loan. Plus, many a times, you were going on faith on the purpose of the loan. The banks at least check to see if they are using the money. Also, given the lack of collateral, I would find it hard to see them giving out larger loans on the information that is currently provided.

I’m betting there are a whole lot of people on these p2p lending networks that have absolutely no idea what they’re doing and are going to wind up losing a lot of money. It’s probably impossible to get a loan for anything over a few thousand dollars and theere are super high interest rates for even small loans.

I have a small sum of money invested in Lending Club as a trial for a possibly larger investment and I think it is a much safer and saner system than Prosper. Lending Club denies loans to anyone below a certain FICO score, so the loans available have already been pre-screened to a certain extent. The maximum loan size at lending club is $25,000, which is more than a few thousand dollars. The lowest interest rate is 7.37%, which is hardly super high. Since June 2007 the default rate is 4.33% according to their statistics. What’s the default rate for loans made through Citi, BoA, or any other bank for that same time period?

Let’s face it. Revolutionary concepts take time to perfect themselves. Prosper made tons of mistakes, Lending Club is still growing, but the idea is starting to prove itself. I’m making 8.04% on LendingClub after a year (their site says avg is 9.75%), UK’s Zopa has been doing it for 3+ yrs with less than 2% defaults and Prosper is making changes to their model to rectify their early mistakes. All in all, it looks like this concept is here to stay.

Evolving business models take time to mature. I hope the “lenders” understand the risk of making loans to people who they do not know. I would not take that risk. Companies like ZimpleMoney.com are based on making loans to people you know; from your church, your neighborhood, or your family. A much safer alternative to P2P financing.